US slump to force a Hardie rethink

Louis Gries, the chief executive of
James Hardie
, doesn’t like to fake it. After a particularly bad third-quarter earnings report last week, when James Hardie not only reported a larger than expected 30 per cent drop in net operating profits but also cut its full-year guidance,
Gries
didn’t pretend to know when the United States housing slump would end.

“None of us actually believe we know when this thing will end or it will be a V-shaped recovery," he said.

It was a sensible answer, given James Hardie got caught out last year by stocking up on supplies of fibre cement and other building materials only to find a hoped-for recovery never materialised.

But being honest doesn’t make being in the wrong place at the wrong time any easier.

While Gries is generally regarded to have done a good job keeping James Hardie afloat during the worst housing market in US history – some 550,000 to 600,000 new homes are now being built each year, one-third of historical averages – the fact remains that two-thirds of the group’s profits are derived from the US.

Not only have sales volumes of building materials been dropping as the overall market shrinks, but the company has also been losing share in the markets and categories in which it operates.

James Hardie has been very successful in developing a market for fibre cement – the mixture of cement, cellulose fibre, sand and water developed by the company in the 1980s – in the US, and now commands a 14 per cent share of the siding market (which also includes vinyl, wood and brick) and controls about 90 per cent of the fibre cement category.

But fibre cement is more expensive than either wood or vinyl and the people who are still building homes in the US are increasingly choosing cheaper cladding materials, like LP Building Products’ “SmartSide" siding, a wood-based product.

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Meanwhile, James Hardie’s competitors, such as CertainTeed (which makes vinyl as well as fibre cement), have been discounting their products, making it more difficult for the company to retain category share.

Gries is not planning to engage in a discounting war, arguing that while the industry is more aggressive on pricing than it ever has been, the price cuts are not sustainable.

He remains confident that James Hardie will be well-placed to pick up market and category share when the housing market recovers (the company is targeting 35 per cent of the siding market).

But with a strong recovery in US housing starts remaining a distant dream – more than a quarter of US free-standing homes are worth less than their outstanding mortgage, making it difficult for people to sell and trade up to bigger homes – James Hardie could stagnate for several years while it waits for a recovery if it does not come up with some new ideas.

The company cannot increase prices to boost profits because a price hike last year has already cost the company dearly in category share loss.

It has already cut production costs at a time when raw materials like pulp, used in the manufacture of fibre cement, are becoming more expensive. And while its Asia-Pacific business (which includes Australia) is performing well, it contributes just one-third of total profits.

The solution may be to follow the lead of consumer goods companies like Unilever and Procter & Gamble, and start developing cheaper products for the bottom end of the market.

Unilever and P&G have traditionally prided themselves on making high-quality branded goods for Western consumers.

But as competition increased during the global financial crisis, many consumers in the US and Europe started buying cheaper “own brand" products made by supermarket chains or discounters like Aldi and Lidl, forcing Unilever and P&G to introduce less expensive versions of their washing powders and body lotions.

James Hardie already has some low-end brands, like Cemplank, and Gries has indicated that if the housing market slump drags on, it will be selling more of it.